The newest data on audit costs suggest public companies, or a least the largest ones, might be getting a handle on the seemingly runaway increases associated with internal controls.
Recent studies from Audit Analytics and the Financial Executives Research Foundation show audit costs indeed continue to rise. Audit Analytics expresses audit costs as a percentage of revenue, showing 2015 audit costs as a factor of revenue increased 9.16 percent for nearly 2,200 accelerated filers. That ratio is driven upward, however, by a 6.7 percent drop in revenue in 2015, largely caused by downward pressure on oil and gas prices.
Across all public companies, FERF’s study found audit costs in 2015 increased a median 3.2 percent, with non-accelerated filers showing the biggest increase at 4.8 percent. Large accelerated filers reported increases of 3.8 percent, and accelerated filers, 3 percent. Smaller reporting companies, which are not subject to the audit of internal control under Sarbanes-Oxley, reported increases of only 2.3 percent.
Both studies also show companies that have taken steps to shore up their internal controls have managed to keep audit costs in check compared with their counterparts. In the Audit Analytics study, 75 companies that received adverse opinions on internal control in 2013 also reported bigger increases in audit costs the following year.
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The FERF study says that the 19.5 percent of all public companies that reported adverse internal control findings in 2015 reported a 5.1 percent median increase in audit costs. That compared to a 3.1 percent median increase for companies without adverse internal control findings.
The FERF study also looked for reasons for cost increases, surveying companies to find out what they consider to be their biggest drivers of audit costs. Merger and acquisition activity topped the list, followed closely by the increased focus in recent years on internal controls at the Public Company Accounting Oversight Board.
Nearly half of the public companies that participated in the survey reported they have managed to mitigate increases in audit costs by improving their internal controls, and more than half said they mitigated increases by making themselves more audit-ready before auditors began their work. A similar number said they managed costs by negotiating with their auditors.
“If we’re seeing increases in audit fees, I’d think it’s a combination of auditors doing more work to document with checklists, making sure they are addressing all possible nuances, and then increases because of new accounting standards.”
Dee Mirando-Gould, Executive Director, Morgan Franklin Consulting
Consistent with the latest FERF findings, smaller companies continue to struggle to meet internal control expectations, says Joseph Howell, executive vice president at Workiva, while larger companies are making improvements in their control environments. “When you look at the companies who are able to manage their audit fees down against the pressure of increases, it was their ability to get a handle on controls,” he says.
Howell especially sees larger companies making improvements in three key aspects: documentation, risk assessments, and management review controls. “They are getting documentation into a more coherent form that is enabling them to tie together their risk assessment with their controls,” he says. “They are getting that linked.
Dee Mirando-Gould, executive director at Morgan Franklin Consulting and a former auditor and staff member at the PCAOB, says auditors appear to be doing more with check lists and documentation to address PCAOB inspection findings. She works with companies that are producing and asking for significantly more memos to document conclusions and analyses as a result of increased audit demands. All of that adds cost, she says.
Below are other key findings from SEC filings:
Audit fees paid by the 6,490 unique filers for their 2015 audits averaged $1.8 million, with a median of $522,205.
The average percentage increase in audit fees was 32.5 percent and the median increase, which reduces the effect of outliers, was 3.2 percent.
The median increase in audit fees by filer status was greatest for non-accelerated filers at 4.8 percent, and least for smaller reporting companies at 2.3 percent.
Over 1,100 filers experienced a decrease in audit fees.
However, over 300 filers experienced an increase in fees of more than 100 percent. These “outliers” tend to explain the significant difference between the average increase of 32.5 percent and the median increase of 3.2 percent.
Almost one-fifth of SEC filers reported ineffective internal controls over financial reporting (ICFR).
For fiscal 2015, the median increase in audit fees for companies with ineffective internal controls was 5.1 percent, almost two percentage points higher than the median for all SEC filings reviewed.
In addition to the analysis of SEC filing information on audit fees provided by MyLogIQ, this report also provides an analysis of responses to FERF’s annual audit fee survey, with responses submitted by executives from public companies, privately held companies, and non-profit organizations. The findings below are based on these responses.
In addition, companies are dealing with an increasing number of new accounting standards, which also adds audit activity, and hence cost. Companies are just taking in new standards around consolidation, the cash flow statement, stock-based compensation, and the going-concern analysis, to name a few. And on the horizon there are more big changes coming with new rules around revenue recognition, leasing, and financial instruments.
“If we’re seeing increases in audit fees, I’d think it’s a combination of auditors doing more work to document with check lists, making sure they are addressing all possible nuances, and then increases because of new accounting standards,” says Mirando-Gould.
Bob Conway, a former Big 4 audit partner who retired recently from the PCAOB inspection staff, says he has questions about the overall cost-benefit equation around Sarbanes-Oxley Section 404 compliance. He says he has yet to see a reliable estimate of exactly how much companies spend annually on compliance because there are so many different aspects to the cost beyond just the external audit. It includes time spent by company personnel, internal audit, and outsource service providers.
The increase in audit costs alone for those companies represented in the Audit Analytics study from before and after the Sarbanes-Oxley Act took effect is sobering enough, he says. “I am supportive of the attention to ICFR in the high-risk areas that are regularly the source of restatements,” says Conway. “But I see a lot of time spent in low-risk areas such as payroll that does not make sense from a cost-benefit perspective.” The low risk areas already get sufficient attention in the substantive audit, he says.
Audit Fees Over Revenue: Percentage Change From Year to Year
Conway believes both auditors and preparers could benefit from additional guidance from the PCAOB to establish guardrails around what constitutes necessary procedures and what might be regarded as excessive. “Auditors have tended to migrate to positions where they can’t be second guessed by the PCAOB,” he says.
Dan Goelzer, a partner at law firm Baker & McKenzie and former acting chair at the PCAOB, says he not surprised to see audit costs steadily rising, given heightened focus on internal controls from the PCAOB in recent years. But as indicators begin to emerge that perhaps some companies are getting their arms around internal control expectations, companies shouldn’t look for audit costs to level off or stabilize any time soon.
“Assuming a stable world, you might assume that ICFR auditing at some point would come into equilibrium,” says Goezler. “But the world isn’t constant.” In addition to new accounting standards on the horizon, auditors too will face new standards, with the PCAOB expected to soon finalize new requirements for the audit report that will lead to new audit work. “All of this stuff has implementation costs associated with it.”